What do you mean by financial valuation? Explain its various types

Capital Market

Understanding an asset's or investment's value is vital in business since money drives everything. Calculating the economic worth of a firm, investment, or asset is known as financial valuation. 

By 2030, GDP growth in economies that use data sharing for finance may range from 1 to 5 percent, with advantages for consumers and financial institutions.

It is an important facet of financial analysis that aids in the decision-making process for people and businesses regarding investments, mergers and acquisitions, and other financial transactions. 

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Various financial valuation methodologies may be used, depending on the scenario. Business valuation is not a one-size-fits-all approach. This blog post will cover what is financial modeling and valuation and examine the many financial valuation models employed by financial analysts and investors.

What is the importance of financial valuation in finance and investment?

Financial valuation is the process of calculating the value of a business, and it's used to determine the value of a business enterprise.

You should incorporate financial modeling into your business intelligence and analytics strategy. With software like Excel, businesses may develop dynamic models that users can relate to crucial financial records like income statements, balance sheets, complicated debt obligations, and more. 

Financial modeling often inputs data from a company's operational and financial history. The financial models offer information and statistics for planning the future, estimating revenue, and projecting expenses.

Some other uses are:

  • Reduce or eliminate a business unit
  • Budget
  • Estimate your capital expenditure requirements and distribute cash accordingly.
  • Be ready for business dealings (e.g., merger, stock buyback, corporate purchases)

Different Types of financial valuation Models

  • Three-Statement Model

A three-statement model is a financial model used in finance and investment. It is a three-statement model that measures the value of a company.

The three statements are:

  • Income Statement: It shows a company's profitability at various levels, with net income as the last line item at the bottom.
  • Cash Flow Statement (CFS) - The CFS accounts for investing and financing operations before adjusting a company's net income for non-cash expenses and changes in net working capital (NWC).
  • Balance sheet: It shows the carrying worth of a company's resources (or assets) and the source of the money used to pay for the assets' acquisition and upkeep (i.e., sources).
  • Comparable Company Analysis: Trading Comps

Trading comps are used to value a company. They're also used to determine a company's worth and compare it with other companies to determine if the stock is undervalued or overvalued. 

For trading comps to be accurate, they must be based on similar businesses that are already publicly traded. If you have access to another company's financial statements, then you can use them as comparable data points while creating your model of their business performance.

  • Discounted Cash Flow Model

The DCF analysis is a discounted cash flow model. It calculates a company's intrinsic value by discounting future cash flows into a single number and then comparing that number with the current stock price.

By discounting anticipated free cash flows to the present, the discounted cash flow (DCF) model considers the time value of money. Leveraged or unlevered free cash flows are also possible.

  • Budget Model

The budget model is a simple way to calculate the value of a company. It calculates its cash flow, which represents how much money it makes each year and how much it spends on items such as wages, rent, and interest payments.

Thus the private equity firm must make sure the following are true:

  • Monthly Free Cash Flows (FCFs)
  • Sufficient debt capacity 
  • Liquid assets that may be sold for cash
  • Very Little to No Cyclicity
  • Accretion/Dilution Analysis: M&A Merger Model

The M&A Merger Model is used to evaluate the value of a target company. It helps determine whether an acquisition will be accretive or dilutive to your company's balance sheet and what kind of premium you should pay to complete the deal.

The various varieties of financial models, outside of the 3-statement and DCF models, tend to become increasingly complex due to the growing number of moving parts. 

Although the fundamentals of M&A modeling are quite straightforward, the following modifications might make the process more difficult:

  • Advanced price allocation for purchases (PPA)
  • Deferred Taxes (DTLs, DTAs)
  • Asset sales versus stock sales
  • Resources for M&A Finance (i.e., Debt Financing)
  • Calendarization and stub year modification

The Final Words

Financial valuation is a key component of the financial industry that aids people and businesses in making judgments about their investments and assets. Investors and financial analysts who wish to precisely calculate an asset's or investment's economic worth must understand numerous investment valuation techniques. 

The innovative Financial Services & Capital Markets Management Program from Imarticus Learning and IIM Lucknow will help you realize your potential for success in the financial services and capital markets sector. This innovative curriculum provides a thorough education covering every market facet, giving you the information and abilities required to succeed in this cutthroat sector.

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